Brexit Could Mean BOE Cuts Interest Rate to Zero, JP Morgan Says

  • JPM model shows 50 basis-point cut would not be unreasonable
  • Governor Carney has said BOE would face challenging trade-off

The Bank of England could lower its key interest rate to zero should the U.K. vote to leave the European Union, according to economists at JP Morgan.

While Governor Mark Carney has warned a Brexit might spark a recession, he also said officials would face a challenging trade-off between stabilizing inflation and stabilizing output and employment. JP Morgan’s Allan Monks assesses the potential implications of an exit and used a Taylor rule -- designed to show the suitable level of interest rates given the economic environment -- to argue the case for easing would be “more convincing.”

“Uncertainty would likely broaden as concerns about instability ripple across the economy, affecting households and businesses,” Monks wrote in a note on the impact of Brexit. “This framework suggests the currency would have to fall by 30 percent to make a rate cut look unlikely.”

The analysis predicts an EU exit after the June 23 referendum would shave about one percentage point off gross domestic product growth over the next four quarters.

Inflation Risk

The model also shows unemployment would rise to 5.6 percent and mortgage spreads would increase by 50 basis points. The U.K. inflation rate would climb to as high as 3 percent by the end of 2017, though inflation expectations would be little changed.

While the stronger consumer-price growth suggests pressure for tightening, Monks says this is “more than outweighed” by the loosening implied by a lower output gap and higher mortgage spreads. The analysis implies a loosening of 55 basis points. With the BOE rate at a record-low 0.5 percent, this can “just about” be delivered without breaching the zero-lower bound, JP Morgan says.

Earlier this month, Carney said the central bank could cut its key rate or use unconventional policy tools if needed. Gertjan Vlieghe signaled he may already be thinking about looser policy, saying on Thursday that the economy may require more stimulus even in the event of a vote to remain in the EU.

“We think the BOE would ultimately ease if events play out as we describe, but show sensitivity to the timing and context of the decision,” Monks said. “Some on the Monetary Policy Committee may, therefore, prefer to ease at or after its next forecasting round in August.”

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